Funny about Money

The only thing necessary for the triumph of evil is for good men to do nothing. ―Edmund Burke

Walking Away from a Mortgage: Is it immoral?

Late last year, University of Arizona law professor Brent White stirred up some controversy by observing that underwater homeowners should feel no guilt about walking away from properties whose value has fallen way below the amount owed on them. Pointing out that the very lenders who cooked up questionable residential mortgages feel no compunction about walking away from underwater commercial properties, White pointed out that buying a residential property is no less a business transaction than buying a commercial one, and that mixing emotion and “morality” into the transaction has saddled homeowners with a disproportionate burden for the current real estate fiasco.

Cutting one’s losses when a property is no longer worth what you’re paying for it is called “strategic default.” Despite the clear fact that a real estate transaction is a real estate transaction, many people can’t get past the idea that individuals, as opposed to corporations, have some moral obligation to stick with a bad business deal. Others argue that what’s good for the corporate goose is good for the individual gander. Just check out some of the comments here and here and here.

The story’s not quite as simple as it seems on the surface. Depending on what state you live in, you may or may not be able to hand a property back to the bank without consequence. In some states, lenders can come after an owner who walks or does a short sale for the difference between the house’s selling price and the amount of the loan. Your credit rating, of course, will be trashed for several years to come. And if Soggy Bottom is not your primary residence, you’ll owe taxes on the amount you defaulted on.

IMHO, White has got something. If you’re stuck with a bad loan for your primary residence and you live in a state where a lender can’t sue you for a deficiency judgment (such as Arizona), it may be financially irresponsible NOT to walk. And there’s no reason to feel guilty or morally incompetent when the mess results from no fault of your own.

M’hijito and I copurchased a small house in mid-town Phoenix’s established, mostly middle-class north central corridor at a time when we believed the real estate collapse was nearing bottom. Our agent, a very smart older man with an MBA and many years of experience in business and real estate, thought the same thing. We estimated the house’s value would drop about $4,000 to $6,000, level out for a year or two, and then begin to rise at about 3% to 6% p.a., the historic rate of increase in that area before the bubble.

Neighbors were furious with our seller for unloading the house at what they thought was a rapaciously low price.

How wrong could we all have been?

The house is now worth (if you believe Zillow) $75,000 less than we paid for it and $51,000 less than we owe.

We planned to hold the house for five to ten years, with M’hijito living in it most of the time or renting it should he take a job in another city or marry and need a larger home. After no more than a decade, at which time I planned to retire, we expected to collect a small profit or at least break even, split whatever equity we recovered, and go on our respective ways.

Now M’hijito feels stuck in the house. Because we can’t even begin to sell the house for what we owe on it, he can’t move to another city in search of a better job (workers are famously underpaid in Arizona) or go out of state to pursue an MBA at a decent school. Having lost my job and seen my retirement savings plummet $180,000 when the Bush economy crashed, I’m in a different financial position (indeed) than I was when we bought the place.

Fortunately, we did have enough sense to get a loan through our credit union. Unlike the banks of recent infamy, the credit union has been willing to negotiate. But they resist even contemplating a cut in principal, which is what needs to happen.

In response to my layoff from ASU, the credit union arranged to prorate our payments over 40 years (instead of 30) and to cut our interest rate to 4 percent. This dropped the mortgage payments into a more affordable range—and to something close to what we could theoretically get in rent.

The deal is good for only a year, however. After that, the credit union will consider renewing it for another year or will give us the option to refinance.

Although of course I’m pleased to see our payments reduced to something almost within reason, I’m still unhappy with the underlying predicament: the house’s value has dropped so drastically that we may never recover our investment in it, and so money paid toward the loan amounts to money down the drain. In an optimistic scenario, it will be another ten years before the house’s value rises to what we owe on the mortgage—to say nothing of the healthy down payment we put down at the outset. And please: don’t even ask what it costs to renovate a 1950 cottage!

For the time being, M’hijito likes the house and is comfortable there. He rents one of the rooms to bring in cash to cover maintenance and repairs. And with the mortgage adjustment, the roof over his head is costing him no more than he would pay for a rental. But the point is, we’re both losing money on the property.

We did everything we could to make a responsible decision: purchasing a house that was certainly no McMansion, selecting a centrally located neighborhood ripe for gentrification and close to the much-ballyhooed lightrail line, buying within our means, avoiding shady mortgage instruments, and selecting a lender that was unlikely to rip us off. And we’re still behind the 8-ball.

A corporation’s board of directors would be remiss not to default under those circumstances. So…should a homeowner be held to a different standard? If so, why?

Image: Tennessee house, ca. 1933-36. Tennessee Valley Authority. Public Domain.

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7 Comments

  1. Here in Canada, banks can (and do) go after people who walk away from mortgages, with gusto. A mortgage is considered a personal, financial commitment like any other loan.

    There’s also no tax deduction for mortgage interest. It’s a wonder that anybody buys houses under those conditions, but they still do.

    However, as a result of more stringent lender policies, the housing market doesn’t have quite the bust-and-boom cycle of the US market. Toronto and Vancouver excepted.

    So, more strict lending policies => more stable housing market => less chance of going underwater on your house. This is NOT the result of clear thinking by Canadian banks – they have often lobbied for changes to the regulations to become more American-like – but it’s interesting how it all worked out.

    I’m truly sorry for all those honest people who find themselves in horrid situations with their houses, but hey – in Phoenix – do you really expect anything to change? It’s a place with little industry, few natural resources, and a dwindling aquifer. Is it a viable place for anyone to live, let alone buy real estate?

  2. I’m torn. On the one hand, I’m sick of corporations getting off more easily than people. But I also feel that, when you make a commitment like a house, you’re obliged to pay it off.

    If you hadn’t planned on selling until 5-10 years have passed, I’m not quite sure I understand how you’re both losing money at this point. You are only losing money if, by the 5 or 10 year mark, you can’t sell it off for at least what you paid. And that’s only if you sell it.

    Also, I’m at a loss as to why your son would need to move if he gets married. The townhouse apparently fits two people pretty easily. And it sounds like he and his wife would have a spare room for an office. Eventually, it could become a nursery, if need be.

    Obviously, you’re hoping to sell off at some point and get your investment back. But for now, I can’t see how you’re *losing* money.

  3. I’m all for the non-McMansion set walking away (and my problem with the McMansion set is only karmic, I still don’t see why they shouldn’t be able to do the same).

    My first (and only relevant) thought would be to investigate what impact the walking away would have on your son’s credit score. He would, as I understand things, still be eligible for all forms of federal student loans for his potential future masters degree. But his ability to get private student loans (evil as they are) would be harmed if his credit got trashed too.

  4. Very interesting thoughts to ponder. Very well written and researched.

  5. I think there are several different issues here.

    To answer your question as to whether or not it’s immoral to walk away from a motgage, I think it depends on what the contract says. If it says they will take the house back if you stop paying, then no I don’t think it’s immoral to stop paying and give the house back.

    Whether or not it’s a good idea to do so because of feeling stuck (which is frustrating) and having an unrealized paper loss is another matter. No one can see into the future (if they could, tons of houses wouldn’t have sold at sky-high priced). Since making the payments aren’t an issue, selling now is just another bet as to what the future might be like.

  6. I really think this depends on how you look at your mortgage: did you make a promise to repay the bank, or did you enter into a business transaction with them?

    In other words, do you think like a normal person (promises should be kept) when it comes to your mortgage, or do you think like a lawyer? If you think like a lawyer (and banks surely do), then promises are promises to perform or to pay damages. Breaching a contract makes good sense when the damages you have to pay are lower than the harm you’d suffer from staying in a losing contract. I think this is called “efficient breach” and is generally considered a good thing among businesses, especially for one-off transactions where your reputation won’t suffer and future business won’t be hurt. (The equivalent here might be credit scores: do those suffer if you walk away? If so, your son might want to think twice about walking, especially if he’s going to be looking for employment in the near future. Some employers will check credit scores.)

    Something else to consider: your bank presumably thinks of your mortgage as a contract of sorts. No doubt it is making you pay a premium to account for the fact that you might default. Of course, that premium probably also has built into it the assumption that people don’t like walking away from their houses and defaulting on their debts. In other words, the bank took into account the fact that you think like a normal person and not like a lawyer when they made you the loan. If they thought you would walk away whenever it was efficient, their risk in making the loan would have been higher and you would have had to pay more.

    If thinking like a lawyer is repugnant to you, that’s a reason to keep on paying. I say this only partially in jest: if you were to feel guilty about walking away, like somehow you yourself were worth less because you had not kept your word, that would be a pretty good reason to stay.

  7. @ Vinny: Interestingly, Canadians buy a lot of real estate here. Some come here as snowbirds during the winter, but many buy as investments. This became quite a problem during the last recession, as so many Canadians bought properties as rentals and then, as absentee landlords, let them go to pot. Several apartment complexes bought under those circumstances had to be condemned, and all over the city individual homes turned into blighted properties.

    Sort of like folks who would never throw their trash on the living room floor tossing their BK wrappers out the car window. 😉

    This area is very much a viable place for people to live, but not, as you point out, for hordes and hordes of people. Our problem is the general stupidity and greed of the leadership, which consists largely of developers (they put themselves into political positions, especially as city council members and county supervisors) in whose interest it is to draw large numbers of new residents. These people don’t give one thin damn that there’s not enough water here for to support a large population, or that blading the Sonoran desert at the rate of an acre an hour is destroying the very thing that brings people here. All they care about is lining their pockets.

    It’s a spectacular place to live. Before the “growth” morons had their way, there actually was plenty of water to support a few small to mid-size cities. But there most certainly isn’t enough to support another sprawling Los Angeles.

    So…we can’t complain about absentee Canadian landlords trashing the place — all they were doing was joining in the fun.